Joe, a longtime reader of this column, called me for a second opinion. He and his wife Mary were planning a three-week trip to Europe. His concern: Make sure his potential estate tax liability was covered in case of a fatal mishap on the trip.

Joe asked his CPA (Charlie) to compute his estate tax liability based on his current wealth. Charlie prepared a worksheet showing all the assets (and their values) owned by Joe, the estate tax liability ($3,227,000), the liquid assets available to pay the tax ($766,100) and the short-fall ($2,460,900). Charlie recommended and Joe bought a $2.5 million term policy on Mary (with Joe as the owner) to pay the estate tax.

It should be noted that Joe (age 61) and Mary (age 58) have a typical traditional estate plan: pour-over-wills and A/B trusts (drawn by a lawyer specializing in estate planning).

I want to zero in on the most common errors I see closely held business owners, like Joe, make in their estate planning... errors (really, missed opportunities to save estate taxes) that cause the Joes of the world to lose millions of dollars of their wealth to the IRS.

Let's start by taking a closer look at Joe's personal wealth. His total taxable estate is $16.7 million: $9.5 million in various investments (mostly real estate subject to $2 million in mortgages); Success Co. (business owned 100% by Joe) worth $4.6 million and nets about $950,000 per year after $275,000 salary to Joe, plus liberal fringe benefits; $1.8 million in a 401(k); $0.8 million in miscellaneous assets, and finally, a $2 million life insurance policy on Joe (owned by him).

Discounts

There is a loophole in the tax law concerning the value of certain assets: A particular asset retains its real fair market value, but has a lower discounted value for tax purposes.

Following is a little chart that shows you the asset class, the strategy used and that oh-so-wonderful discount.

Asset Class

Strategy

Discount

Business

Nonvoting stock

40%

Investments

Family limited partnership

35%

Residence

Split-ownership*

30%

*Typically, 50% of residence owned by husband's A/B trust and 50% by wife's

We implemented the above three strategies for Joe. The discounts totaled $5.565 million, bringing the taxable estate down to about $11.2 million (actually $9.2 million without the $2 million insurance policy, which we will deal with later).

Freeze the major assets

Here gifts (to the three kids) are the weapon of choice. We used the annual exclusions of $14,000 per donee ($28,000 for Joe and Mary combined), followed by using a portion of the lifetime credit (in 2013) of $5.25 million ($10.5 million for both). An intentionally defective trust (IDT) was used to transfer the non-voting stock of Success Co. to Joe's kids... a tax-free transaction.

Important: Even though the assets were out of Joe's estate, he continued to control them.

Insurance

This is complicated stuff. You must (1) know the law, (2) understand the life insurance products available in the marketplace, (3) keep the policy proceeds out of the insured's estate and (4) minimize the cost of premiums. Sadly, few professionals know how to get the job done.

Let's deal with Joe's two policies one at a time.

The $2 million policy: The annual premiums were $15,349 with a cash surrender value (CSV) of $52,000. A second-to-die policy on Joe and Mary (really what they need because no estate tax is ever due until both husband and wife have gone to heaven) has a lower premium of $10,521. The decision was easy... Drop the old policy. Joe pocketed the $52,000 CSV. A new second-to-die policy for $2 million was purchased by an irrevocable life insurance trust to keep the death benefit out of their estate.

The $2.5 million policy: First, a fact... the policy was no longer needed to pay estate taxes, which were eliminated by the above planning. But when, I told Joe that the premiums could be paid by the IDT, he was on board to have the IDT buy a $2.5 million second-to-die policy on Joe and Mary (for the benefit of their kids) and, of course, it was structured to be estate tax free.

Some help with your life insurance planning: Can you guess what is the most messed up area in estate planning?... Yes! Life insurance. Wrong type of policy. Overpay premiums. Proceeds subject to estate tax. Either over insured or under insured. Actually, I could write a book.

But the following should help you determine if you are in insurance hot water and should get a second opinion:

1. You are married, have single life insurance (typically on the husband), but logic tells you second-to-die will give you more bang for your premium buck.

2. Your policy is paid up... you no longer pay out-of-pocket premiums. Guaranteed to enrich the insurance company, instead of your family. Simply use a tax-free exchange to significantly increase the death benefit, and still pay no premiums.

3. In general, (a) have more than $350,000 in CSV, (b) $3 million in coverage or (c) the policy is more than 10 years old. Old policies should be updated. Typical result -- significantly more death benefits for the same premiums dollar.

4. It's smart to have your insurance policies reviewed by an independent set of eyes every three years (get a second opinion).

IRVING L. BLACKMAN has been practicing accounting and law more than 50 years, specializing in wealth transfer, business succession and valuation. He was a founding partner of Blackman Kllick Bartelstein LLP, CPAs, one of the largest accounting firms in the country, and is a member of the Illinois Society of CPAs, American Institute of CPAs and the American Speakers Association, among other organizations. Blackman has authored 21 books on taxation and penned hundreds of articles for trade publications. His company, Tax Secrets of the Wealthy, is headquartered in Naples, FL. He may be contacted at (847) 674-5295 or Irv@IrvBlackman.com.